China is a large consumer of global oil, and the health of its economy is an important factor in global oil demand

China is the second largest consumer of oil by country, behind the United States. Therefore, changes in China’s economic environment can significantly affect global oil demand and therefore oil prices, affecting valuations of oil companies such as ExxonMobil (XOM), Chevron (CVX), ConocoPhillips (COP), and Hess Corp. (HES) as well as energy ETFs (exchange-traded funds) such as XLE (Energy Select Sector SPDR).

The Purchasing Managers Index is an important economic indicator

One of the indicators that the markets watch to gauge economic health is PMI, or the Purchasing Managers Index. The Chinese PMI is a data point released by the China Federation of Logistics & Purchasing and National Bureau of Statistics. PMI points above 50 indicate that the manufacturing sector is generally expanding, and PMI points below 50 indicate that the manufacturing sector is generally declining. The reading is based on five major factors, including new orders, output, employment, supplier delivery times, and inventories.

July’s PMI was lower than expectations, oil prices dropped

For the month of July, China’s PMI reading (as reported by HSBC, which differs from the PMI reported by the China Federation of Logistics and Purchasing)was 47.7 compared to economists’ estimates of 48.2 and June’s reading of 48.2. The lower-than-expected figure was negative, as it means that the manufacturing sector grew less than expected. Additionally, the lower figure month-over-month indicates that growth was decelerating. China’s economic condition is a major data point for oil prices because China’s now the world’s second largest oil-consuming nation, and growing demand from China and other developing countries has helped make up for slackening demand from the struggling Eurozone. Oil prices dropped on the day, with WTI crude finishing at $105.39 per barrel compared to $107.23 per barrel the day before.

Negative indicator in the medium term

This weaker-than-expected PMI data point was a negative medium-term indicator. Overall, this is negative for Chinese oil demand. It puts a damper on oil prices and therefore also the valuation of oil stocks such as XOM, CVX, COP, and HES and energy ETFs such as XLE.